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P O L I C Y B R I E F I N G 5| 2 0 20

What would be the impact of a possible EU Carbon Adjustment Mechanism on Ukraine?

David Saha, Georg Zachmann

Berlin, April 2020

UKRAINE

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Structure

1. Introduction

2. Current plans for an EU CBAM

3. Possible design of an EU CBAM

4. Carbon intensity of Ukraine’s exports to EU

5. Potential impact of an EU CBAM on Ukraine

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1. Introduction

Background:

• The EU Commission has announced the possibility of introducing a Carbon Border Adjustment Mechanism (CBAM) as part of its Green Deal

• A CBAM would tax goods imports into the EU according to the CO2 emissions generated by their production

• Purpose of a CBAM: To ensure that EU green measures do not lead to a shifting of CO2-intensive production to third countries

• Such a tax could affect Ukrainian exports to the EU

Purposes of this Policy Briefing:

• Explain the state of discussion around an EU CBAM

• Outline different design scenarios for the CBAM

• Analyse potential impact of the CBAM on Ukraine’s exports to EU

➢ Purely hypothetical analysis for different possible implementations as no concrete CBAM proposal exists to date

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• An EU “Carbon Border Adjustment Mechanism” (CBAM) was proposed by Commission President Ursula von der Leyen in her election programme

• Intended to prevent “Carbon leakage”: “The expected relocation of carbon-intensive production from regions with tight emission regulation (i.e. high carbon prices) to regions with looser emission regulation (e.g. lower or no price on carbon)” (Zachmann and McWilliam 2020)

• In “The European Green Deal” communication (Dec. 2019), the Commission announced that it will propose a “carbon border adjustment mechanism, for selected sectors, to reduce carbon leakage”, if differences in the level of ambition persist worldwide.

• Inception Impact Assessment (March 5, 2020) contains 3 options for a CBAM:

1. A carbon tax on selected products, both on imported and domestic products

2. A new carbon customs duty or tax on imports

3. The extension of the EU ETS to imports.

• Commission plans to submit a respective legal proposal by 2021.

➢ An EU CBAM may be implemented eventually, but no concrete proposal exists nor is there a timeline for a definite implementation

2. Current plans for an EU CBAM

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• A partial model would reduce complexity and transaction costs of a CBAM, but risk leakage through a move of emissions imports down the value chain

• The EC communication stated that they will prepare a proposal for a „carbon border adjustment mechanism, for selected sectors”

• Not impossible that a comprehensive model is favoured in the end

3. Possible design of an EU CBAM

Main question: Scope of CBAM

All goods import to EU subject to CBAM

Comprehensive coverage

Partial coverage

Scope Description Considerations for implementation

• Difficult implementation, high transaction costs

• But prevents leakage through value chain

Only imports of selected (carbon-intensive) sectors

subject to CBAM

• Currently favoured by EC• Easier implementation• Avoidance possible: E.g. nails (no

CBAM) instead of steel (CBAM)

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• Carbon intensity highest for lower-value products with energy-intensive production

– High carbon intensity of metals, mining industry, minerals and coke exports

• As many of these products are extensively traded, often referred to as CITE (Carbon intensive, trade exposed)

➢ At first glance, restricting a CBAM to CITE sectors makes sense

➢ But: Mostly inputs into downstream sectors. Partial CBAM risks carbon leakage through moving down the value chain

Rationale for partial or comprehensive CBAMCarbon intensity of exports by industry, EU-28 and new

EU member states, 2015

Source: OECD.Stat

t CO2 per USD m

0 200 400 600 800 1.000 1.200 1.400 1.600

Other manufacturing; repair and…

Transport equipment

Machinery and equipment, nec

Computers, electronic and electrical…

Fabricated metal products

Basic metals

Other non-metallic mineral products

Rubber and plastic products

Chemicals and pharmaceutical products

Coke and refined petroleum products

Chemicals and non-metallic mineral…

Wood and paper products; printing

Textiles, wearing apparel, leather and…

Food products, beverages and tobacco

Mining and quarrying

Agriculture, forestry and fishing

EU new member states EU28

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Implementation options and aspects

3 options for the basic design of the “tax”1. Carbon tax, both on imported and domestic products2. Carbon tax/duty on imports, domestic products remain on EU ETS3. Including importers in EU ETS➢ Inclusion in ETS probably easiest and most consistent approach

2 options for calculation of carbon content of imports1. Using benchmark values, e.g. those used for free ETS allowances:

Based on emissions of 10% least polluting EU installations=> Unrealistically low values, regardless of prod. technology

2. Calculation of actual emissions: Complex work for exporting companies, effectively a technical barrier to trade (TBT)

Ensuring WTO compliance• Usually requires non-discriminatory treatment of imports• Some exception rules exist, but unlikely to be used• Also requires no discrimination among partner countries➢ Compliance would require either an end of free ETS allowances in

CITE industries or an EU-wide carbon tax

➢ Inclusion of imports in EU ETS & (gradual) phasing-out of free allowances most plausible ➢ Calculation method remains uncertain

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• Only exports to EU (42% of total goods exports) would be exposed to CBAM

• Most exposed products: Metals exports, USD 3.1 bn in 2019

• Also: Petroleum products (USD 0.7 bn), possibly: Ores (USD 1.7 bn)

• Other large exports not very emission intensive

➢ 16% - 27% of exports to EU are emissions intensive

4. Carbon intensity of Ukraine‘s exports to EU

Ukraine‘s exports by product group, 2019

Source: Ukrstat, 2019

Total exports: USD 50 bn Exports to EU: USD 21 bnFerrous metals

15%

Cereals13%

Electrical machines

11%

Ore9%Fat and oil

7%

Preparations from ferrous metals

7%

Wood5%

Petroleum3%

Furniture3%

Food wastes3%

Reactors, machines

2%

Preparations from ferrous

metals2%

Others20%

Cereals19%

Ferrous metals

17%

Fats and oil9%

Ores, slags, ashes

7%

Electrical machines

6%

Oil seeds and fruits

5%

Nuclear reactors

3%

Remains of food industry

3%

Wood3%

Preparations from ferrous

metals2%

Others25%

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• Despite decrease 1990-2017, Ukraine remains extremely carbon intensive due to heavy reliance on fossil fuels, low energy efficiency and sector structure

• Much of carbon intensity due to electricity and heat sector

• UA steel production also more emissions-intensive than in other countries

• High reliance of steel production on coal/coke (70% oxygen furnace vs 68% electric arc with relatively clean fuel mix in USA, Zachmann and McWilliam 2020)

Emission intensity of the Ukrainian economy

Carbon intensity of selected countries, 1990 and 2017

Source: IEA Data Service

0

0,5

1

1,5

2

2,5

3

3,5

Ukraine Belarus China Russia Poland Germany France UK Sweden Norway

in % CO2 emissions per 2010 USD of GDP

1990 2017

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5. Potential impact of an EU CBAM on Ukraine (1)

Implementation through tax or extension of ETS to imports• Under ETS, emissions prices vary cyclically (for all producers)• Tax/customs duty implementation: No specific impact on UA

exports compared to any other duty/tax

WTO compliance• Would probably imply that EU producers also pay for CO2

emissions (phase-out of free ETS allowances or EU carbon tax)• No discrimination possible among different exporters to EU➢ Controlled for the level of emissions, UA exports are not made

worse off on EU market vs. EU/third country producers

Comprehensive or partial coverage of the CBAM?• Main impact on UA due to steel/petroleum products exports,

which would be targeted in partial coverage CBAM• Partial coverage would reduce compliance burden (emissions

calculation) on less emissions-intensive industries➢ Main impact not dependent on comprehensive/partial coverage

Direct impact: Implications of EU policy choices for Ukraine (1/2)

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Potential impact of an EU CBAM on Ukraine (2)

Calculation of carbon content of imports• Using ETS benchmark values for emissions: Ukrainian producers

would even pay less than EU producers as benchmark calculated on 10% most efficient EU industries

o As price for affected goods in EU rises: Reduced demand for these goods, but UA producers do not lose competitiveness

• Using actual CO2 intensity: Ukrainian exports subject to higher CBAM than producers from countries with cleaner technologies

o UA producers lose competitiveness vs. “cleaner” producers plus demand effect due to increased price in EU

o Calculation of carbon content may be a hurdle for smaller companies

• Likely “intermediate” scenario: Adapted benchmark (e.g. EU average emissions) with the option for companies to prove they are less emissions-intensive than the benchmark

➢ Important difference

Direct impact: Implications of EU policy choices for Ukraine (2/2)

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Indirect impact

• CBAM could lead to re-routing of exports and split e.g. the steel market in two markets for “green steel” and “dirty steel”. Non EU “green steel” producers might export own produce and import “dirty steel” for their own needs

• Phasing out free ETS allowances in the EU may benefit UA as these function as an implicit subsidy when allowances were allocated too generously

• Partial coverage CBAM could be an incentive for investing in downstream technologies in UA to evade CBAM

• CBAM could stoke global protectionist tendencies

Further considerations

• If CBAM is waived for imports from countries with an “adequate” carbon pricing, UA might consider introducing a carbon tax to ensure revenues stay in UA

• Should follow and participate in EU discussion on whether CBAM proceeds should be fed back to the respective countries of origin

• Political considerations may contribute to regulatory exceptions of some countries from CBAM on basis of (alleged) use of cleaner technologies etc

Potential impact of an EU CBAM on Ukraine (3)

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• G. Zachmann, B. McWilliam (2020): „A European carbon border tax: much pain, littlegain“, bruegel, Policy Contribution, Issue no.5.

• F. Guarascio, J. Ekblom (2019): “Explainer: What an EU carbon border tax might look like and who would be hit”, Reuters, https://www.reuters.com/article/us-climate-change-eu-carbontax-explainer/explainer-what-an-eu-carbon-border-tax-might-look-like-and-who-would-be-hit-idUSKBN1YE1C4.

• M. Mehling. H. van Asselt, K. Das, S. Droege (2019): “What a European ‘carbon border tax’ might look like”, voxeu.org, https://voxeu.org/article/what-european-carbon-border-tax-might-look.

• D. Gros, C. Egenhofer, N. Fujiwara, A. Georgiev, S. Guerin (2010): “Climate Change and Trade: Taxing carbon at the border”, CEPS research paper, https://www.ceps.eu/ceps-publications/climate-change-and-trade-taxing-carbon-border/.

• EU Commission (2019):“A European Green Deal, Striving to be the first climate-neutral continent”, https://ec.europa.eu/info/node/123797.

References

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